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GCC banks stand out from global peers and are poised for extraordinary years ahead: report

RIYADH: A robust oil and gas sector, high interest margins and fintech innovation will help support banking sector growth in the Gulf Cooperation Council region in 2024 and beyond, according to a new report.

Analysis carried out by the global management consulting firm McKinsey & Co. found that despite global macroeconomic volatility, financial institutions in the region outperformed their international peers in 2023 thanks to an exceptional operating environment and the sector is set to perform strongly this year.

Global banking faces significant challenges following the COVID-19 pandemic, including rising prices and rapid tightening of monetary policy.

The US central bank quickly raised interest rates, which increased bank profits, but also the risks of unrealized losses, as evidenced by the collapse of Silicon Valley Bank and the takeover of Credit Suisse.

Tensions in the Middle East and prolonged high interest rates in the US could put further pressure on global prices. These problems led to a 10 percent decline in price-to-book value, reducing the capitalization of the global banking market by $900 billion.

A report by McKinsey & Co. struck a bullish note on the GCC banking sector, saying it “boasts exceptionally high returns on equity and some of the highest multiples in the world”.

The report adds: “The regional financial sector has delivered healthy returns to shareholders over the past decade, outperforming the global average.”

McKinsey & Co. highlighted that the Total Shareholder Return Index, which tracks the dividend-adjusted share prices of more than 80 GCC financial institutions, has consistently shown excellent growth trends compared to global benchmarks from 2010 to 2024.

This underlines the sector’s ability to deliver stable returns for shareholders amid global economic volatility.

GCC banks also maintained higher levels of return on equity and stronger market multiples globally. Despite the recent reduction, their ROE from 2022 to 2023 consistently exceeded the global average by three to four percentage points, reflecting their effective capital management and profitability in a challenging global banking environment.

Increased interest rates have played a significant role, driving regional and international banking profits to record highs and supporting GCC banks in creating significant value for shareholders.

In addition, GCC banks boast higher net interest margins and income-to-asset ratios than the global average, according to the firm. With net interest income of 2.3 percent, above the global norm of 1.4 percent, regionally wider profitability margins are indicated.

Despite facing higher impairment costs compared to global peers, GCC banks operate with lower operating costs and demonstrate effective cost management strategies. Their average ROE of 10.9 percent reflects a strong capitalization that outperformed the global average of 9.0 percent.

The overall favorable macroeconomic environment, characterized by high hydrocarbon prices and strong economic growth, supported the GCC banking sector’s strong balance sheets and stable growth trajectory.

Resilience to face global risks

GCC banks have shown resilience to the recent global shocks, which contrasts with the challenges facing the wider international banking sector.

McKinsey & Co. report. she emphasized that while global economic connectivity offers opportunities for growth, it also increases the risks of instability, accentuated by increased geopolitical tensions and regulatory scrutiny.

The firm said these trends are occurring against a backdrop of accelerating climate change – a global risk multiplier that also represents a multi-trillion dollar opportunity to finance the transition to low-carbon growth.

McKinsey’s macroeconomic scenarios predict that global banking conditions will worsen in the coming years, leading to a peak and subsequent decline in the return on equity of GCC banks.

Nevertheless, the region’s sector is better equipped to meet these challenges compared to its peers. Their banking ratios are expected to diverge positively from global trends, highlighting their resilience and relative strength in handling future economic uncertainties.

According to a 2023 study by Ernst & Young, rising demand for banking services, growth in digital banking and regulatory reforms such as the introduction of Basel IV are expected to help drive growth in the sector.

Liquidity management

However, despite the favorable environment, GCC banks face challenges, especially interest rate fluctuations. The firm noted that global tight monetary policy and faster growth in funding than deposits required careful liquidity management.

The analysis showed funding grew by 14 percent annually in the kingdom from 2019 to 2022, outstripping the 9 percent growth in deposits. High interest rates are driving mortgage lending as governments encourage home ownership, impacting GCC banks’ retail loan portfolios.

The average loan-to-deposit ratio of Saudi Arabian banks increased by 18 percentage points from 2020 to 2022, indicating future potential liquidity problems. High rates can also change consumer and business behaviour, affecting non-interest-bearing liabilities and savings and investment patterns.

Total loans in Saudi Arabia are projected to reach 5.04 trillion SR ($1.34 trillion) by 2030, growing by 10 percent annually between 2024 and 2030, the report said.

Wholesale loans will have the largest share with 69 percent, followed by mortgages with 21 percent and consumer financing with 11 percent.

Conversely, deposits are expected to reach SR 3.54 trillion by 2030, growing at a rate of 5 percent per year. Wholesale deposits will make up 53 percent, the remaining 47 percent will be retail deposits.

The ratio of total loans to deposits is expected to rise to 142 percent from 104 percent in 2024, indicating that deposit growth in Saudi Arabia is not keeping pace with funding, adding to liquidity pressures.

Since 2020, GCC banks have significantly intensified their activity in international debt capital markets. The aim of this strategic move is to strengthen their funding growth strategies, diversify funding sources and, recently, mitigate the high cost of liquidity in the domestic market.

According to a recent report from Fitch Ratings, emerging market dollar bond issuance, excluding China, exceeded $200 billion in the first five months of 2024, with issuers from the kingdom leading with 18.5 percent of total issuance.

Despite challenging financial environments, these banks have competently managed liquidity issues, which is supported by greater access to government sukuk and liquidity management tools provided by central banks.

These measures are designed to ensure a sustainable level of liquidity and enable banks to meet financial obligations and maintain operational stability in fluctuating market conditions.

Innovations and technologies

McKinsey & Co. highlighted the key transformative factors shaping GCC banks, including innovation, machine learning and generative artificial intelligence, as well as high digital penetration and the impact of fintech on reshaping the industry.

In addition, GCC regulators are actively developing an open banking framework to further support the development of the sector.

Abdulla Al-Moayed, CEO of Tarabut, praised Saudi Arabia’s adoption of open banking in an interview with Arab News in May.

He highlighted efforts to collaborate between banks and fintechs to innovate and expand market reach, signaling a significant development towards digital transformation in the Kingdom’s banking sector.

Generative artificial intelligence and other advanced technologies are poised to revolutionize banking operations, increasing client engagement and operational efficiency.

Fintech advances such as digital payments and sophisticated financial products are gaining traction in the GCC, driven by growing demand for personalized digital services.

McKinsey & Co. noted that fintech firms are expanding their portfolios beyond core offerings to serve both the consumer and business sectors, supported by significant funding and expanded digital adoption in the region.

At the same time, traditional banks are launching new digital initiatives to remain competitive, highlighting the dynamic and evolving banking landscape across the GCC.

An example was given of how regulators in Bahrain and Saudi Arabia are supporting innovation through open banking frameworks in line with global standards. This has spurred local startups and encouraged established institutes to adopt new technologies.

The report says open banking increases competition and IT costs, and offers benefits such as expanded customer reach and new services. It also requires banks to adapt to seize opportunities in managing profitability risks.

recommendations of McKinsey & Co

GCC banks are poised to effectively navigate global economic uncertainties, but must remain proactive rather than complacent, the report warned.

Key priorities for bank executives in the region include managing volatility around interest rates through robust asset and liability management and stress testing.

Measures should also be taken to increase operational efficiency by digitizing processes and automating routine tasks that optimize human resources.

Transforming the customer experience by offering real-time personalized products to a digitally savvy population is critical, as is maintaining a focus on environmental, social and government initiatives that support global climate change efforts.

In addition, creating shareholder value through strategic M&A and restructuring allows banks to capitalize on emerging market dynamics, freeing up capital by divesting non-core assets and refocusing on core operations.

These priorities underline the proactive stance of GCC banks within the evolving economic environment.

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